Post on 16-Jul-2020
?, 2017 | ?2enr.com/SpecialAd
SPECIAL ADVERTISING SECTIONO
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Insurance Today II
Rebuilding America: Preparing for Increased
Infrastructure Spending
The Surety Industry ◆ Market Overview
◆ Executive Viewpoints
◆ Avoiding Pitfalls
◆ Mitigating Risks
◆ Sustainable Planning
WHAT’S INSIDE
IN AN
INSTANT,
ERIC LOFTON
SAW THE VALUE
OF CNA SURET Y
A CONTRACT WON AND A RELATIONSHIP REAFFIRMED
MARCH 11TH, 8:01 A.M.
Construction • Education • Financial Institutions • Healthcare • Manufacturing
Professional Services • Real Estate • Retail • Technology • Wholesale Distribution
To learn more about the complete range of CNA Surety bonds for construction, contact your local independent insurance agent, or visit www.cnasurety.com.
It would be their largest contract
undertaken — installing the HVAC system
for the nation’s largest new shopping mall.
Needing to provide a Performance and
Payment Bond, Eric Lofton worked closely
with his independent insurance agent and
the experienced underwriters from CNA
Surety. Eric’s agent arranged a site visit with
the mall developer, and helped Eric secure
the bond that ultimately sealed the deal.
Way to build your business, Eric.
TS
The examples provided in this material are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice. “CNA” is a service mark registered by CNA Financial Corporation with the United States Patent and Trademark Office. Certain CNA Financial Corporation subsidiaries use the “CNA” service mark in connection with insurance underwriting and claims activities. Copyright © 2017 CNA. All rights reserved.
June 26/July 3, 2017 | I4enr.com/SpecialAd
Insurance Today IISPECIAL ADVERTISING SECTION
There are nearly 4 million miles
of roads, 600,000 bridges, 90,000
dams, 140,000 miles of track with
more than 100,000 rail bridges,
3,000 airports and close to 100,000
public schools throughout the United
States. The American Society of
Civil Engineers rates the overall
infrastructure in the in United States
as a “D+.” Needless to say, America’s
infrastructure is in desperate need of
updating. Politics aside, the proposed
$1-trillion infrastructure budget by
the current administration signals
increased opportunities for the nation’s
construction industry.
The Surety Information Office
(SIO) explores Rebuilding America:
Preparing for Increased Infrastructure
Spending. Through a combination
of interviews and discussions with
industry leaders, along with examining
market trends, the SIO offers practical
insights to help prepare the construction
industry for the increased infrastructure
spending.
The U.S. Census Bureau reports
a 4.2% growth rate for the entire
construction industry in 2016, while
The Surety & Fidelity Association of
America (SFAA) reports a 7% growth
in the surety market from 2015 to 2016.
The continued growth levels indicate a
greater market capacity for underwriting
surety bonds. Ross Fisher, chair of
SFAA and senior vice president of
Specialty Commercial for The Hartford,
says, “With surety growth ambitions
and so much surety capacity available,
credit-worthy—and even some less
than credit-worthy—companies can
find surety capacity on acceptable
terms.” An increase in capacity coupled
with a range of products, such as bid,
performance and payment bonds, means
that surety bonds have never been a
smarter investment for companies
seeking to benefit from a potential
infrastructure bill.
Small
The surety market for the
small contractors remains highly
competitive—in line with the previous
year. The SBA Surety Bond Guarantee
Program continues to offer small
contractors the opportunity to bid
on larger contracts. The program
guarantees up to $6.5 million,
while fast-track bond programs for
construction companies with positive
credit scores keep the market robust.
“During my 44-year career in the
surety industry, I have never witnessed
such an aggressive market for small
contractors,” says Howard Cowan,
president of NASBP. Michael Gross,
vice president of contract surety for
CNA Surety, adds, “A record number
of new surety firms have entered the
market in the past 10 years, with many
having an appetite for small contactors
that have a solid business plan
emphasizing controlled growth.”
Surety Market OverviewBy Bryan Surcouf, Communications Manager, The Surety & Fidelity Association of America
I5 | June 26/July 3, 2017 enr.com/SpecialAd
SPECIAL ADVERTISING SECTIONInsurance Today II
MediumSimilar to the small market, the
medium market remains extremely
competitive, particularly for the more
established companies with solid
balance sheets. “This is the ‘sweet
spot’ for virtually every surety,” Cowan
explains. “Companies are competing
to keep their existing accounts and
to add to their book of middle-sized
contractors.”
One issue with this market is that
contractors may attempt to grow
beyond their capacity. According to
Josh Penwell, vice president of contract
underwriting for Merchant’s Bonding
Co., “A larger number of surety
markets are marketing for small- and
medium-size accounts. Underwriters
are challenged to remain disciplined,
as contractors in the middle market
may have interest in expanding outside
of their normal geographical area or
pursue projects that are much larger
or more complex than their typical
projects.”
LargeAs a record number of surety
firms entered the market over the
past 10 years, the large surety market
remains extremely competitive. “Large
contractors that have maintained
adequate balance sheets have ample
surety capacity,” Penwell says. “There
are certain sectors, such as oil and gas
and health care, where the amount
of work is increasing, and larger
contractors are taking advantage of
that.”
The opportunities for growth and
available bonding capacity at this level
are not without risk. “Surety companies
actively embrace large contractors, but
underwriters understand that this market
has the potential to be challenging due
to many contactors attempting to ‘take
the next step.’ Underwriting centers on
managing risk and growth, cash flow
and earnings retention,” Gross says.
“Underwriters are being challenged to
properly analyze the risk associated
with creative delivery systems, such as
public-private partnerships,” Penwell
adds.
MegaOnly six surety companies work
with the mega contractor market.
These projects are more complicated
and require underwriters to fully
understand not only the contractual and
operational risks involved but also the
individual contract provisions, such as
shortened schedules. Those sureties
and contractors with the capital can
make a lasting impact in this market
as the backlog of contracts approaches
the billion-dollar range. “More states
have passed or will pass legislation
enabling the P3 delivery method, and
the federal government is expected to
ramp up the number of P3 projects,”
Gross says. “Infrastructure spending
will most certainly increase. Finding
qualified labor for the expected increase
in projects is paramount to success.”
Contractor FailureConstruction is a risky business.
Unforeseen issues can cause even well-
established contractors to default on
a project. There are many reasons for
contractor failure, but two of the most
recognized are when contractors attempt
to venture out of their area of expertise
or geographic area without fully
understanding the new market. Onerous
contract terms also can play a role in
default for contractors.
Markel Surety President and COO
Michael Keimig says, “Contractor
failures increased slightly in 2016—but
not at an alarming rate. Larger than the
impact of more frequency is the impact
of rising costs to complete bonded
projects in default due to material and
labor price escalations. On the prime
level, margins are holding steady to
inching up slightly depending on the
region. Subcontractors are more able
to put margin in their bids, but the
increased pressure to find skilled labor
adds inherent risk to their work.”
“Contractors’ profit margins appear
to be improving,” Cowan adds. “The
major contractor failures that did
occur have caused significant losses
to the writing surety. In the small and
middle markets, claims activity, but
not necessarily losses, has increased.
Payment bond claims appear to be more
common than performance bond issues.”
Value and ProtectionSurety bonds are the best protection
for consumers, businesses and taxpayers.
“We are in the era of potential
alternative options to contractor surety
bonds, including subcontractor default
insurance, corporate guarantees and
ILOCs,” Gross says. “None of the
alternatives can bring the total package
that a surety bond brings, including 1)
payment to all subcontractors, laborers
and suppliers; 2) the most rigorous and
educated prequalification process; 3)
administration of completion of the
contract; and 4) price that is generally
less expensive than alternatives.”
“An often unseen and under-
appreciated benefit of a surety
bond is the prequalification process
provided by the surety,” Cowan says.
“It adds the considered judgment of a
major financial corporation that the
contractor will successfully perform the
contract and pay the associated bills.
If its judgment proves to be faulty or
unforeseen events create a default, the
surety’s financial assets will pay for the
additional costs up to the penalty of the
bond.”
“Capital is at a premium, and
surety bonds protect an owner or
general contractor’s capital from the
unexpected,” Keimig adds. “You
cannot predict pressures that impact
a construction firm over the life of a
project, but for typically less than 1%
The U.S. Census Bureau
reports a 4.2% growth
rate for the entire
construction industry
in 2016, while the SFAA
reports a 7% growth in
the surety market from
2015 to 2016.
Not all projects are this simple. That’s why you need Travelers’ new EDR bond.
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© 2017 The Travelers Indemnity Company. All rights reserved. Travelers and the Travelers Umbrella logo are registered trademarks of The Travelers Indemnity Company in the U.S. and other countries. CP-8953 New 4-17
I7 | June 26/July 3, 2017 enr.com/SpecialAd
SPECIAL ADVERTISING SECTIONInsurance Today II
of the contract price, you can protect
your investment. In a typical default
scenario, that 1% premium protects
against what could equate to a full
contract price loss. As a private owner
or prime contractor, one of your greatest
risks in delivering a project is the loss
of capital due to faulty workmanship or
unpaid subs or suppliers. A surety bond
equates to capital preservation with
both a prequalification component and a
dispute-resolution provision.”
Merchant’s Penwell believes the
three main reasons a construction
owner or contractor should require
performance and payment bonds are:
• Surety underwriters are trained
to evaluate the risks associated
with various contractors and also
determine the appropriate levels
of projects and programs that a
contractor should undertake. The
premium charged for this service
is more cost effective and efficient
than attempting to handle this
internally.
• The payment bond provides
protection against subcontractors
and suppliers who could lien the
project if they don’t get paid.
The payment bond mitigates
the exposure from second-tier
subcontractors, suppliers to
subcontractors and union dues.
• Performance and payment bonding
will help ensure that project
owners, architects, lenders and
end users will be satisfied. It will
save substantial overhead expenses
in the form of lower legal fees,
less management time spent on
nonproductive issues and less
time spent sending unnecessary
correspondence.
Private Construction and Surety Bonds
As private owners and banks attempt
to mitigate the risks associated with
construction, there has been a growing
trend to require surety bonds. Bank
lenders are leading the way in the
private construction arena. “There does
seem to be a growing trend by private
owners (or banks) to require bonds for
their projects—and that’s just good
business,” Keimig says. “We are seeing
an increase in the use of payment and
performance bonds from both general
contractors and in the private sector,”
Penwell adds. “Sophisticated general
contractors and risk-averse private
owners understand that payment and
performance bonds are a cost effective
and efficient way to mitigate the risk of
contractor and subcontractor failure.”
Gross expanded on the subcontractor
bond market by adding, “Subcontractor
bonding has been on the decline over
the past five years due to the increased
use of subcontractor default insurance
(SDI) by large general contractors.
However, due to experience with
SDI over the past few years, surety
companies are writing more subcontract
bonds for general contractors that
use SDI but are excluding specific
subcontractors due to increased
perceived risk. Outside of SDI, the
use of subcontractor bonding has been
consistent with prior years. The biggest
change is that contractors are becoming
more sophisticated in prequalification,
and most continue to use subcontractor
bonding in one form or another as part
of that prequalification process.”
Looking AheadLeaders and industry experts
predict that the surety market will
remain strong, and they expect to see
a continued increase in contractor
revenues and margins throughout the
remainder of 2017. The potential $1
trillion in additional infrastructure
spending over the next 10 years will
help this trend to continue.
When looking to the future, Fisher
states, “The surety marketplace is strong
based on the improving construction
economy and the fact that construction
companies have weathered the 2009–
2012 downturn pretty well. When our
customers are doing well, the surety
marketplace generally reflects that. The
product line is profitable, contractors
and other users of surety have many
choices, and most will find plenty of
capacity.”
“Forecasted moderate growth in
construction spending will keep work
plentiful,” Keimig adds. “The greatest
risks to the industry will be continued
upward pressure on interest rates and
materials pricing, and the impact of a
dearth of skilled labor, which will cause
projects to take longer and cost more. As
well, these same pressures will drive up
the cost to complete defaulted work.”
Penwell concludes by saying,
“Without disciplined underwriting,
contractors that have backlogs of work
that are larger, have thin margins or
have work in areas where they lack
experience will have challenges. The
availability of skilled laborers is a big
concern as talk of infrastructure money
becomes reality. It could be a factor in
increasing losses if contractors don’t
properly manage their personnel. We
expect to continue seeing unfavorable
terms and conditions that will challenge
contractors. Surety capacity is plentiful,
with stable underwriting results, a
number of new markets entering the
surety industry, and several reinsurance
companies attempting to expand by
establishing primary operations.” ◆
“Capital is at a
premium, and surety
bonds protect an
owner or general
contractor’s capital
from the unexpected.
You cannot predict
pressures that impact a
construction firm over
the life of a project,
but for typically less
than 1% of the contract
price, you can protect
your investment.”
—Michael Keimig, President
and COO, Markel Surety
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H I I G C O N S T R U C T I O N
June 26/July 3, 2017 | I10enr.com/SpecialAd
Insurance Today IISPECIAL ADVERTISING SECTION
What do you believe the new federal administration’s anticipated infrastructure plan will mean for the surety market?
Michael Gross,
Vice President of
Contract Surety,
CNA Surety: The
forecasted expansion
will result in new
work and profit opportunities, and
the surety industry is ready to help its
qualified contractors responsibly grow.
There is sufficient capacity in the surety
market to bond the anticipated increase
in spending. The nature of the expansion
will require sophisticated surety support
with the capacity to support larger
projects at varying delivery methods,
especially the intricacies and contractual
complexity of the anticipated increase in
P3 work.
Writing more bonds carries
additional risk, as higher surety
premium does not always translate into
more profit. Overextension is one of the
leading causes of contractor failure, and
a large infrastructure plan may stretch
contractors both operationally and
financially. Contractors that have a deep
workforce, including access to sufficient
labor, will have an advantage. Capital
requirements will be discussed by surety
companies to ensure their clients will
have the financial means to cash flow
the expansion and weather potential
storms.
Strong strategic leadership will
be the key to success not only for
contractors but for their surety partners
as well. The expansion provides an
excellent opportunity for both the
surety and contractor to strengthen
their relationship by increasing
communication.
Is the U.S. construction industry ready to address a trillion dollars in infrastructure spending?
Michael Keimig,
President and COO,
Markel Surety:
While the industry
has made great strides
in recent years with
more efficient delivery models and
construction methods, the impact of a
trillion dollars of construction spending
would be major. At current spending
levels, there is already a significant
amount of pressure on the skilled labor
market. Adding that level of work on
top of it would perhaps be more than
the industry could bear. While the
contractors that have the best training
and labor sourcing practices may fare
better than the others, the entire industry
would be impacted by the trickle-
down effect. Along with the skilled
labor shortage, the working capital
needed to fund the increased backlogs
would put major cash-flow hardships
on many firms. These issues would
almost certainly lead to more contractor
failures and highlight even further the
benefit of surety bonds.
How can surety bonds help contractors grow and be profitable?
Ross Fisher,
Senior Vice
President, Specialty
Commercial, The
Hartford, and
Chair, The Surety
& Fidelity Association of America:
Growth and profit sound great, but
neither exists without risk. Growth
creates risk, well-managed risk is the
engine for profit, and profit comes from
risk that you can see, price and manage.
For general contractors, surety bonds
fit within an overall risk management
program. Bonds can provide real
protection when used alongside a
thorough sub prequalification process,
proactive project management and cost
accounting, and the use of various risk
transfer tools. Used in this way, surety
bonds can protect against subcontractor
risk, allowing a general contractor
to stretch into larger projects, larger
backlogs, and other new opportunities
as part of a business plan to grow and
improve the company’s profitability.
For subcontractors, surety bonds
are an affirmative statement of one’s
qualification to do the work and pay
bills. While this may not help manage
the subcontractor’s risk, it does make
subcontractors more attractive to general
contractors and, in some cases, project
owners who are trying to manage their
risk. Used proactively and confidently,
surety bonds can help subcontractors
win work on more attractive terms
because the sub represents reduced
risk for the potential client, the general
contractor or project owner.
Confidence is key for general
contractors and subcontractors—
confidence that the bonding company
knows them, their organization and
long-term plans, and is willing and
able to support them when proactively
choosing to use surety bonds. Neither
GCs nor subs can run a business looking
over their shoulders to see if their surety
company is still with them.
Executive Viewpoints
“Growth creates risk, well-managed risk is
the engine for profit, and profit comes from
risk that you can see, price and manage.”
— Ross Fisher, Senior Vice President, Specialty Commercial,
The Hartford, and Chair, SFAA
I11 | June 26/July 3, 2017 enr.com/SpecialAd
SPECIAL ADVERTISING SECTIONInsurance Today II
Howard Cowan,
President, NASBP,
and Principal,
Cowan-Hill Bond
Agency: Surety
bonds are a critical
resource for contractors wishing to
grow and become more profitable.
The key ingredient provided by
the surety industry is the guidance
provided by surety underwriters and
producers in their roles as trusted
professional advisors. Whether it is
a new construction company or one
that has experienced financial and/
or operational difficulties, contractors
are likely to spend more time with
their surety advisors than their CPAs,
lawyers or bankers. The reason is not
that the underwriter or producer has
more expertise in those areas; it is
because they are in the best position to
maximize and coordinate the talents of
the contractors’ professional advisors.
The surety bonds that result from such
coordination put the contractor on a
path to both profits and growth. The
frequent contact with the contractor and
the continuous prequalification done
by the surety industry not only leads to
growth and profitability, but it also helps
the contractor become a better business
professional.
What steps can contractors take in preparation for more infrastructure spending?
Gregg Lyon, Second
Vice President and
Strategic Officer,
Construction
Surety, Bond &
Specialty Insurance,
Travelers: Given the current state of
Infrastructure in the United States, it is
clear that the country needs to address
the aging infrastructure problem.
Politically, the House and Senate concur
that an increase in federal infrastructure
spending is warranted but disagree how
to pay for the increased spending levels.
To put it in prospective, the President
has discussed a $1-trillion infrastructure
package over 10 years, and the Senate
Democrats have floated the idea of a
similar-size package. The questions at
this point are:
• How long will it take for Congress
to pass a new infrastructure
spending bill?
• What will the new infrastructure
spending bill look like?
• What is the time frame before
shovels are in the ground?
Since financing is one of the main
obstacles to reaching a compromise
for a new infrastructure bill, a possible
solution could involve the expanded
use of public-private partnerships. P3
spending has increased in the United
States, and a number of states recently
passed P3-enabling legislation. We also
understand that several large private
equity firms in the United States are
working on new funds to finance
infrastructure spending.
As a contractor prepares its
organization for future infrastructure
opportunities, or any growth
opportunities for that matter, there are
a number of steps we believe our clients
should take to best position themselves
for future success:
1. Ensure that your strategic business
plan is up to date and action plans
are clearly identified.
2. Share this plan across your
organization so that the
stakeholders at all levels of your
company take ownership and have
accountability.
3. Also share your strategic business
plan with your key business
partners, including your surety,
surety agent and bank.
If your business plan is to grow,
either in the short term or long term,
there are a few critical areas we suggest
to focus on:
Staffing: Review your staffing
plans to confirm your company has
the expertise to grow and expand.
Recognizing the relatively tight labor
markets, getting out ahead of resource
needs can be one of the biggest success
factors for your company, as it gives
you a head start on identifying the right
talent now.
Systems: Review internal systems
and confirm they are meeting
expectations and can support your
growth plans. We recently conducted
a review of accounts that encountered
financial difficulties, and one common
deficiency we noted was in the area
of internal cost systems—more
specifically, the lack of good internal
financial controls. It’s not about having
a good system in place, it’s about using
that system effectively to manage your
business.
Financial: Ensure that your
balance sheet can support the future
opportunities you are looking to pursue.
An emphasis should be put on liquidity,
capital and bank support to handle an
influx of new projects or growth in
general. The last thing you want to do
is to have ample work opportunities
without the financial wherewithal to
execute on them.
While the White House and
Congress debate various proposals, this
pause gives infrastructure contractors
adequate time to review their individual
operations and capabilities to make
sure they are ready for the long overdue
increase in infrastructure spending. ◆
“Recognizing the relatively tight labor
markets, getting out ahead of resource
needs can be one of the biggest success
factors for your company.”
— Gregg Lyon, Second Vice President and Strategic Officer,
Construction Surety, Bond & Specialty Insurance, Travelers
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June 26/July 3, 2017 | I14enr.com/SpecialAd
Insurance Today IISPECIAL ADVERTISING SECTION
We are on the brink of a potentially
significant and rapid expansion
in infrastructure spending. An
increase in the number and size of
construction projects is always a
welcomed occurrence, as more work
should translate into shorter bidder
lists, higher margins on bid day and,
most importantly, more winning bids.
But why is the contractor failure rate
relatively the same during an expanding
market versus a recessionary market?
Why do many contractors take on more
risk but make less money at higher
sales volumes? The answers center
around three main pitfalls to avoid in
expansion: loss of controls, insufficient
risk mitigation and inadequate attention
to capital requirements.
When backlogs increase, in an effort
to meet deadlines and mitigate potential
problems, previously implemented
organizational and financial controls
are often put on the back burner.
Organizational control discipline may
be softened in areas such as failure to
implement a business plan, centralized
checks and balances in bid review,
weekly meetings to discuss projects
and lessons learned, and overall failure
to quickly place significant additional
resources on problem jobs. Lax internal
controls during increased backlog levels
most often result in late diagnostics
of problem projects, causing costs to
rapidly escalate, sometimes to runaway
status. Proper financial controls are
equally important during expansion.
Set and maintain detailed metrics,
and incorporate those metrics in the
business plan. Most surety companies
will provide benchmark reports to be
used as a financial comparison tool, and
that can be incorporated into financial
metrics and goals.
Contractors are being asked to take
on more risk than ever before, and there
are more constraints in place that can
derail profitability plans, even in an
expanding market. Risk management
techniques are more important than
ever. Examples include negotiating out
unfair, onerous contract provisions,
rigorous and disciplined subcontractor
prequalification, properly anticipating
and addressing potential labor shortages,
confirmation of financing, avoiding the
temptation to aggressively pursue work
out of territory and scope, and working
with outside professionals who are
aligned with your goals and understand
your need to grow. Joint ventures are
often overlooked but should be seriously
considered, with the right partner,
to spread risk and maximize surety
capacity. Early establishment of detailed
continuity plans, both organizationally
and financially, help the organization
in many facets, including leadership
transition, key employee progression
and retention, and overall capital
preservation.
Follow the adage of never taking on
a project that by itself could put your
firm out of business. This may seem
elementary, but on occasion, contractors
sign contracts that contain unlimited
actual and consequential damages or take
on projects that are significantly above
the firm’s capability. Measured growth
and measured risk taking are important
considerations during expansion.
Having an experienced CFO
with commensurate experience to
the size and sales of your firm will
help navigate the additional capital
constraints placed on your business.
Most companies forecast sales and
profit, but cash flow forecasting, both
quarterly and individually on each
job, is a critical, often overlooked tool.
During expansion, “cash” should be
a key component of every discussion
point, from bid day to project start to
project completion. Successful firms
emphasize receivable collection more
than unsuccessful firms and have
key people outside of the accounts
receivable department involved in the
collection process.
Increasing overhead expense in
anticipation of more work can be
a mistake. Rather, while difficult,
contractors that set overhead for a
worst-case scenario and ramp up
when backlogs actually increase reap
the benefits. If paying bonuses to
key employees, attempt to do so on a
combination of individual job results
and overall firm results.
Surety underwriters, agents and your
banking professionals often request a
plan toward earnings retention, which
is critical in achieving goals in an
expanding market. Sureties often see
contractors withdraw or bonus out all
profit during good times, only to wish
the money was later there to help cover
overhead when the construction cycle
changes. Resist the temptation to divert
money from the business to sources and
ventures unrelated to construction. You
can never have enough cash, but if you
feel you do, invest in the business.
During an expansion, stay true to
the plans, procedures and controls that
have led to success and enabled you to
capitalize on the upcoming increase in
construction spending. Build up your
balance sheet as a cushion during the
good times, as the only certainty in
construction is that times will eventually
change. The great firms make money at
varying sales volumes and during every
construction cycle. ◆
Infrastructure Repair and New Building: Avoiding Pitfalls in an Expanding MarketBy Michael Gross, Vice President of Contract Surety, CNA Surety
Follow the adage
of never taking on a
project that by itself
could put your firm
out of business.
I15 | June 26/July 3, 2017 enr.com/SpecialAd
SPECIAL ADVERTISING SECTIONInsurance Today II
When a developer hired a contractor
to build a hotel on the East Coast, the
developer required that the contractor
furnish performance and payment
bonds for the $15-million project.
During construction, the contractor’s
finances dried up, and the contractor
had to file for bankruptcy. Because the
contractor was bonded, the surety took
over the project and hired a replacement
contractor, enabling construction to
finish on time. Not only did the surety
rescue the hotel project, but it also
arranged for the contractor’s two other
ongoing projects (a credit union and a
high school) to be completed as well.
Another well-established contractor
incurred an $11-million loss over two
years on a $60-million hotel project.
The future of the contractor and the
completion of the hotel and six other
bonded projects were at risk. The
surety determined that the contractor’s
financial problems were not related to
its performance and provided financial
assistance to the contractor so that it
could complete the projects.
Construction is a risky business.
Unlike other business transactions
where the supplier or vendor knows
what its costs will be, a contractor’s
delivery of a building or other facility is
based on only an estimate of expected
costs. In addition, construction costs can
be affected by many variables, such as
staff turnover, ownership succession,
weather, differing site conditions,
change orders and work stoppages.
Construction contracts
also are distinctively risky because
no two projects are the same. The
contractor’s profitability and cash flow
are affected by altered estimates, which
can affect the contractor’s financial
health and threaten its existence,
possibly leading to an unfinished project
as well as unpaid subcontractors and
suppliers.
Statistics help illuminate the special
risks the construction industry faces. A
publication released by The Governing
Institute in collaboration with The Surety
& Fidelity Association of America
states, “Research conducted between
2013 and 2015 found that contractors
have a failure rate of approximately 29
percent, meaning that one in four of these
businesses will fail, leaving unfinished
small- and large-scale construction
contracts in their wake.”
In light of the risks of construction,
the federal government and all 50 states
require that construction contracts of
a certain size be bonded. For example,
at the federal level, the Miller Act
and related regulations require that
construction contracts of $150,000 or
more be secured with a performance
bond and a payment bond. Legislators
have determined that it is sound public
policy to protect taxpayers against the
excess costs of defaulted construction
projects.
A performance bond provides
assurance that the project will be
performed in accordance with the
terms and conditions of the contract. A
performance bond helps to provide the
project owner and lender the certainty
that qualified contractors are hired to
perform the work, and second, that
financial protection is available in the
event the contractors fail.
Payment bonds provide
subcontractors and suppliers payment
security. Subcontractors and suppliers
that have not been paid the amounts
due by the contractor can seek financial
recovery under the payment bond. With
respect to private projects, a payment
bond helps assure the owner that the
property (collateral for the construction
loan) will not be burdened with
mechanics liens.
Performance and payment bonds
provide the project owner two forms
of protection. The first form of
protection is prequalification. That
is, a surety provides a bond only to a
contractor that it has determined is,
in the surety’s estimation, capable of
performing the work and meeting its
payment obligations. This involves the
surety’s review of the financial strength
and capabilities of the contractor in
determining whether to provide a bond.
In the event of the contractor’s
default, the surety steps in to provide
the second benefit of the bond, which
is financial protection. Typically, the
amount of the performance bond is
100% of the original contract price,
and the amount of the payment bond
is 100% of the contract price. Thus,
200% of the contract price is available
to satisfy the contractor’s defaulted
obligations. The remedies to a default
typically are set forth in the bond form.
Lastly, the surety can provide
benefits unknown to the project owner,
even when the project is not in default
to assure the continued operation of the
contractor. For example, a surety, in
order to avoid the contractor going into
default, may provide financing to the
contractor to meet payroll. This ensures
that the laborers will show up on the job
to continue the work.
As the governmental entities and
taxpayers prepare for the possibility
of increased infrastructure spending,
surety bonds should play an essential
part to provide critical security. The
risk management benefits of bonding
are indisputable. Over the past 15 years,
sureties have paid nearly $12 billion
under performance and payment bonds
that have ensured that contractors
stay afloat and that projects are able
to be completed in a timely manner.
Performance and payment bonds
should be essential tools in the risk
management toolbox for project owners
in the construction industry. ◆
Performance and Payment Bonds: Mitigating Risk in ConstructionBy Robert Duke, General Counsel, The Surety & Fidelity Association of America
Strength.Service.Surety.
SureTec is now Markel Surety, and in many ways, it is business
as usual—same team, same locations, same products. We now
have the resources of a Fortune 500 company (Markel
Corporation – “MKL” on the NYSE) which is good for us,
our professional surety producers and
independent agents, and their
clients. We are excited about the
future and look forward to
partnering with you.
markelcorp.com | markelsurety.com
Markel Surety’s products and services are in partnership with Markel Specialty, a business division of Markel Service Incorporated.Contracts are underwritten by one or more Markel insurance companies. Terms and conditions may vary.
Project Solutions for Worldwide Risks
Project Advisory Solutions for Reducing Construction Risks
Building Envelopes • Structural Systems • MEP Systems • Grading and Drainage • Utilities
Design Documentation • Constructability • Quality Control Plans • In-place Work • Site Safety
June 26/July 3, 2017 | I18enr.com/SpecialAd
Insurance Today IISPECIAL ADVERTISING SECTION
That feeling of elation when a
contractor wins the bid on that big
job can quickly turn to panic without a
good plan in place. Contractor default
can inflict large losses on everyone
involved. This is why surety bonds are
used to secure the successful outcome of
a project. Almost all public construction
projects and many private projects are
backed by surety bonds.
The key for a contractor to execute a
profitable project is to properly evaluate
and mitigate risk. This can sometimes
be a difficult task with projects
increasing in size and complexity. It is
imperative for a construction company
to be surrounded by a solid team of
advisors in order to sustain profitability.
That team includes a professional
surety agent, a surety underwriter, a
banker that understands the needs of
contractors and a construction-oriented
certified public accountant (CPA).
The team will provide advice on key
financial decisions, project selection,
subcontractor prequalifications,
succession planning and many more
components of your business.
Your surety team is going to discuss
avoiding the most common causes
of contractor failure—especially the
internal factors that the construction
company can control. Three situations
that sureties see often are:
1. Pursuing work in a new and
unknown geographic territory.
2. Going into new lines of
construction.
3. Large increases in job size.
Often these larger projects have
complexities that were not part of
the smaller contracts the company
is used to.
There are many other causes of
contractor failure, such as the lack
of a succession/continuity plan when
something catastrophic happens to
the construction company owner, or
personal issues, such as divorce; but
they can all be avoided by working with
your surety professionals. A team of
trusted advisors will set a construction
company on the right path to long-term
success. ◆
Small and Emerging Contractors: I Won, Now What? Creating a Sustainable Plan and Avoiding DefaultBy Josh Penwell, Vice President of Contract Underwriting, Merchants Bonding Co.